Personal Wealth Law News

This post was written by The Beringer Group:

In the US, the family business has, since the end of WWII, been one of the great producers of both jobs and wealth.  And yet, if one reads the literature, one knows that most family businesses don’t last beyond two generations.  This can be due to many causes, but one of the most prevalent is the lack of planning to tax-effectively pass the business from one generation to another.

As the senior generation business owner ages, and the next generation prepares to enter the business or, having entered, to assume more responsibility, it is typical for all of the equity and control to be and remain in the hands of the senior generation.  The owner who really wants to keep the business in the family needs to begin thinking about whether equity is an asset or a liability and about whether all that he/she really needs (or wants) is control until such time as the younger generation is ready to assume company leadership. continue reading

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Last year’s big revision of the retirement plan rules, the Pension Protection Act of 2006, made an important change in the way in which death benefits paid from a retirement plan are taxed.

In many retirement plans maintained by employers, there is a provision stating that if the employee dies before all benefits are paid, the balance will be paid in a lump sum promptly after the employee’s death. There is a simple reason for this: the employer doesn’t want to remain responsible in any way for the balance remaining- better to get it out of the plan.

That’s not been a problem if the beneficiary is the surviving spouse. If a surviving spouse were entitled to the death benefit, it was possible to roll over the lump sum payment to an IRA. By doing that, the surviving spouse could postpone being taxed on the death benefit until it was actually needed. The spouse had to comply with minimum distribution rules under Section 401(a)(9) of the Internal Revenue Code, but those rules permit a long stretchout of payments. It’s a simple rule: if you don’t need the income until later, it’s better to be taxed on it later.

But that option wasn’t available to other beneficiaries. For example, if the employee’s children were named as the beneficiaries for the death benefits, and the retirement plan provided for the payment of death benefits in a lump sum, the children would be taxed immediately. That meant that there would be no opportunity for the advantages offered by tax deferral.

The Pension Protection Act of 2006 changed those rules. Non-spouse beneficiaries of death benefits from a retirement plan can roll them over to an IRA and enjoy the benefits of a stretchout of payments, again subject to the minimum distribution rules.

But since the law was enacted, some “wrinkles” have appeared. First, the non-spouse beneficiaries can’t roll over from a retirement plan to an IRA unless the retirement plan specifically permits it. It’s not clear why a plan wouldn’t want to allow such rollovers, but it’s a choice the plan must make.

Second, the transfer must be a direct trustee to trustee transfer. It must go from the plan trustee to the IRA trustee or custodian. It can’t be distributed to the beneficiary and then rolled over to the IRA.

Third, you have to be prompt in making the decision to roll over. If a non-spouse beneficiary becomes entitled to a death benefit before the employee had to start receiving benefits, there’s a special rule for rollovers. If the beneficiary rolls over the benefit in the year of the employee’s death, the entire amount can be rolled over. If the rollover takes place in the year after death, a minimum distribution must be taken out first, which can be based on the beneficiary’s life expectancy. If the rollover is delayed beyond that year, minimum distributions might have to occur based on a five year distribution schedule, and the distributions from the rollover IRA might also have to be made on a five year schedule. This would cause the loss of much of the benefit of stretchout. This is a complicated issue, and the best advice is to consider the rollover possibility as soon as possible after the plan participant has died. Doing so can create a very favorable tax result.

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After doing the calculating called for in the prior posts, you now know the remaining living expenses needed to provide the baseline retirement, and now need to calculate whether the retirement account you expect to have at retirement will be adequate to pay those expenses. You can make an estimate of what your account will be at retirement by assuming a certain level of contributions and a rate of return similar to that you’ve experienced over a substantial period of years. In addition to the retirement account you have in a 401(k) or similar plan, you might have other investments: stocks, bonds, real estate, but these can be lumped together with your formal plan account to determine what you will have a retirement.

Suppose you have the dollar amount of what you will need for your remaining retirement expenses, after Social Security and pensions, and also an estimate of your retirement account. Now what? You need to determine how long that account will pay your expenses. To answer that question, many math-oriented financial professionals have run studies to determine how likely you are to be successful in paying your expenses over a wide range of possible outcomes. There seems to be some consensus that a 3% or 4% withdrawal rate is the safest course; so, $1,000,000 would permit a withdrawal of $30,000-40,000 per year. If that number covers your remaining retirement expenses, your chances of having a successful retirement are good; if those percentages are inadequate, you might take some risk by withdrawing a higher percentage. But how high can you go? If the needed percentage is higher than a reasonable rate of return on your retirement account, then you’re in risk of running out of money. Certainly, if you go beyond 6% or 7%, you’re in troubled waters. It’s then that you must consider delaying retirement or doing some kind of work in retirement. This method of calculation isn’t nearly as scientific or exact as some would suggest, but it allows you to get a fairly good idea of how much you need to retire.

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By using the template in the prior post, you can get a good idea of your current living expenses. It’s amazing how many people spend without any idea of what daily life costs them. If you have the approximate number of your current expenses, how do you get to the number you will need in retirement? You can begin with the baseline assumption that, when you retire, you will live just about as you are now, with a few changes:

• subtract commuting and other expenses of working.
• add something for additional medical and dental expenses; perhaps double what you’re spending now.
• add something for vacations and other fun things to do in retirement.

Now, you have an idea of what retirement would be like, and cost, if you just continued your current lifestyle. That’s your baseline. You can live at a higher level and estimate higher expenses to do so; or you can assume you will cut back to a more modest lifestyle, which many people find difficult to do. But the baseline gives you a starting point of what a “normal” retirement would cost.

Once you know that, it’s time to consider where you will get the income to pay for that retirement. Social Security will be a part of it, perhaps not a large part. If you or your spouse is entitled to a pension, that will be another piece. Beyond that, there are two sources of retirement income: your accumulated retirement account, whether in a 401(k), profit-sharing, 403(b) or 457 plan; and any income you earn by working in retirement. Actually, the amount you “plug in” as income earned from working will depend on how your retirement account covers your remaining living expenses. So we are at the point of considering the remaining living expenses not covered by other sources and what retirement account is needed to cover them.

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I often ask clients how much they are spending now, and almost always the answer is “don’t know”. This comes up most often when one spouse has died and that spouse handled most of the financial matters. The surviving spouse isn’t sure that he or she has enough to live on, or perhaps enough extra to begin making gifts to family members. Often, surviviors can afford to make gifts to children and grandchildren, but don’t realize it because they don’t know what they need for living expenses and, sometimes, seem paralyzed by the need to calculate it. Well, you need to start somewhere, and so here is a template I have given to clients to help them determine how much they are spending on the expenses of daily living. It’s not necessary to develop numbers down to the penny, but this will give some idea of what’s needed.
continue reading

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We often see commentary about how much a person needs to retire, and often that commentary suggests the need for some percentage of pre-retirement income, such as 70% or 80%. It’s not easy to predict what someone will need in retirement, but pegging it to some fixed percentage of income earned during working years is clearly wrong. This is either sloppy journalism or an effort to encourage people to deal with a brokerage firm. It’s probably fair to say that any generalization as to the amount needed that is supposed to cover all situations is guaranteed to be incorrect. Perhaps the idea is to get people to think about retirement needs. OK, we’re thinking about it. Now what? In some following posts, we’ll go into how individuals can make this calculation for themselves. Meanwhile, a piece of simple advice comes from Ben Stein, who writes excellent articles about retirement and related subjects in the New York Times: it’s better to be rich and healthy than poor and sick.

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A recent dispute over a Washington will highlights the necessity for clients to frequently review their estate plans, especially when those plans include wills or trusts that bequeath significant assets to charitable organizations. The Washington case involved a decedent who left $264 million in his will to eight charities, including the Salvation Army and Greenpeace. The decedent left the Greenpeace bequest to “Greenpeace International”; however, that group was dissolved and absorbed into the related “Greenpeace Fund” during the year before the decedent’s death.  The Salvation Army disputed the executor’s plan to distribute the Greenpeace share to the Greenpeace Fund, arguing that the organization named by the decedent in his will was defunct and that its successor was not eligible to receive the gift. The dispute was finally resolved in a recent settlement agreement, with the Greenpeace Fund agreeing to take $27 million from the estate — $6 million less than it was allotted under the terms of the will.

This feud over the will’s language demonstrates the necessity of frequently reviewing estate planning documents to ensure that the charities named in them continue to qualify for 501(c)(3) tax exempt status, and that those charities continue to have the same names.  The dispute also underscores the need for charities contemplating or executing a name change or transfer of assets to publicize the change and to inform both current and potential donors.

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I think there are two reasons why there is now so much interest in planning for the future in family-owned businesses:

• the baby boom generation, a significant percentage of the population, is heading toward retirement age, and bringing with it many businesses that were started 10, 20 and 30 years ago.
• we’ve had 40 or more years of fairly good times in the US- some recessions and economic downturns, but no event like the Great Depression to wipe out people’s hard work.

What is involved in family business planning? Well, this is what it isn’t: it isn’t a package of documents run off a computer, to be signed by family members to transfer ownership of a business. What is it? It’s a process of learning what people want and don’t want; of helping them to understand how they can achieve what they want, and when they can’t achieve it; of helping families to remain close despite different financial situations and opportunities.

More than anything else, it’s a process of listening to what people think and hope to achieve. Most owners of family businesses are very intelligent, but not trained or experienced in how and when to pass on ownership or control of the business. The assistance we can provide is to be good listeners and then to apply our own experience in finding ways, through various planning techniques, to help families achive their goals. At that point, we might become involved in preparing estate plans and business transition plans, and in guiding owners through legal concepts in transferring ownership.

There are many pieces to the puzzle of successful family businesses. In future entries, we’ll review some of those pieces to see how they can help in making family transition successful.

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